Our annual report sets out the economic position of low to middle income households, traces the origins of today’s squeeze on living standards and charts the long road to recovery for ordinary working households in Britain.

Introduction

We now know that the squeeze on living standards will be longer and deeper than projected this time last year. Average wages are not expected to rise in real terms until late 2014 after a period of stagnation and decline, and many people continue to work fewer hours than they would like, putting downward pressure on household incomes.

If this were not gloomy enough, further problems are being stored up. The incremental impact of changes to the uprating of benefits and tax credits will become visible over time in poverty statistics. And with further reductions in public spending anticipated in this year’s spending review, there will be profound challenges for services, as well as deeper cuts to welfare spending.

The upshot of this on-going economic malaise for Britain’s households is that an already difficult situation will get worse before it gets better. To some extent, all families have been affected since the recession. Indeed, new data shows that, although the very wealthiest have pulled away from low, middle and upper-middle income households over the longer term, in 2010-11 real incomes fell right across the income distribution and most of all at the very top rather than in the middle or bottom. And, while tax and benefit changes have in general hit poorer working-age households harder than richer households, particularly those with children, it is the very richest that have seen the biggest falls of all since 2010. As a result, the latest year saw the biggest decline in income inequality in the last 50 years. Whether this pattern will be replicated in future years remains to be seen.

Of course, households in work but on below middle income, especially those with children, start with far less than the better off, making any squeeze particularly hard to cope with. With wages falling and tax credits no longer providing the support they did in the 2000s, these households with an average income of only £21,000 after tax face a daily struggle to keep up with the rising costs of essentials. Meanwhile, longer term goals such as saving or buying a home are drifting further from reach. These households are the focus of this report.

The causes of the economic challenges facing households are complex and entrenched. It is, therefore, inaccurate and unhelpful to imply that the current squeeze on households is all down to ‘austerity’. The origins of this story stretch back before the recession and cannot be attributed to a single period of government. The challenge is structural as well as cyclical. In the five years prior to the financial crisis of 2008, all but the richest 10% of households failed to benefit adequately from economic growth. Looking forward, we have a long way to go simply to get back to where we were before the downturn, to bring living standards back to their level in the mid-2000s. Above all, the challenge is, as we inch towards a long awaited recovery, how to ensure that the benefits of future growth are fairly shared.

In most instances our analysis focuses on median earnings and incomes rather than mean. In order to best capture changes in the cost of living pressures faced by low to middle income households, we use the Retail Prices Index (RPI) measure of inflation which incorporates a broader range of goods than the Consumer Prices Index (CPI) used by the government to uprate benefits. Substituting CPI for RPI in the analysis included in this report reduces the apparent pace of slowdown in median earnings and incomes identified from 2003 onwards, though the overall trend is similar. A detailed discussion of the effects of adopting different measures and deflators is provided in Trends in Wages and Incomes: 2003-08 available on our website.

Who’s in low to middle income Britain?

Households on low to middle incomes are defined by the Resolution Foundation as those of working age and relying primarily on their own earned resources but with incomes below the median in the UK. The definition does not include the poorest 10% of households and those who receive more than one fifth of their gross household income from means tested benefits.*

The low to middle income group makes up nearly one third of working-age households in Britain. Half of the households in the group have dependent children. Overwhelmingly in work, these households nevertheless manage on relatively modest incomes, leaving them susceptible to something as simple as an unexpectedly large fuel bill.

A couple without children in the low to middle income group lives on a gross annual household income of between £12,000 and £30,000; a single parent with two children on £13,000 to £32,000 and a couple with two children on between £17,000 and £41,000**. On average, this group has seen a 2.4% real terms fall in post-tax incomes between 2009-10 and 2010-11. We define those above the middle as ‘higher income’.

Prior to 2010, wages for workers in the bottom half stagnated but household incomes in this group were propped up by growing tax credits. With the retrenchment of public spending in full swing, tax credits now make a smaller but still highly significant contribution to income for these families and their contribution is likely to continue to decline over future years.

Home ownership among this group is also in decline, while private renting is becoming more common. Nearly a quarter of the group now live in a privately rented home compared to the national average of 17%. Meanwhile, numbers in the social rented sector have flat-lined, as social housing has become increasingly targeted at the most vulnerable.

Moving in and out of the group

Of course, the low to middle income group is not fixed over time. In any one year, around one-third of people leave the group. Of those who leave, nearly two-thirds move up to the higher income group, while close to one-third fall into the benefit-reliant group. These proportions have not changed significantly over time.

Compared to the average person in a low to middle income household, those who fall down into the benefit-reliant group are more likely to have children and are less likely to own their own home. Not surprisingly, those who move up are more likely to be employed than the average, to have a degree, own their own home and have savings. They are also less likely to have children.

Those who leave the low to middle income group are replaced in similar proportions by people falling down from the higher income group or climbing up from the benefit-reliant group. Compared to the average person in the benefit-reliant group, those who move up are, not surprisingly, more likely to be employed. They are also less likely to have children and less likely to be a carer. Those in the higher income group who move down are less likely to be employed, to have a degree and to have savings and are more likely to have children.

Looking back from 2008, over a four year period, more than 50% of working-age people find themselves living on a low to middle income for at least one year. Compared to those who do not spend any time in the group, those who are there for one year or more are more likely to have children and live in a larger family. They are less likely to have a degree and less likely to have savings.

Going further back, we see that 61% of those who were in the group in 2008 were also in the group three years earlier. 50% were there 10 years earlier and 42% were in the group 15 years earlier. This does not mean that they remained consistently in the group in every year of this period. There is a lot of churn so in many cases, they will have moved out and returned. A smaller proportion will remain year on year in the group. In 2008, 47% of people in low to middle income households had remained ‘stuck’ in the group continously for the previous three years.

Living with the squeeze

Although household incomes for all groups have fallen in real terms since the recession, low to middle income households feel the squeeze particularly acutely because they spend a greater proportion of their income on essentials than higher income households. The cost of essentials such as food, fuel and transport have risen much faster than inflation in the overall economy in the last decade, leaving the group facing an ‘inflation premium’.

With more of their disposable income going towards essentials, cost pressures take their toll. Nearly 60% of the group is struggling to keep up with bills either sometimes or all of the time, with a further 7% being behind with at least one household bill. Families in the group frequently have to go without things more affluent families take for granted. 40% say that they cannot afford to replace worn out furniture, compared with 14% on higher incomes and 46% say that they cannot afford a week’s holiday compared with 18% among higher income households.

Low to middle income households find it hard to save because daily living costs eat up nearly all of their monthly income. Just over half have no savings at all and two-thirds have less than a month’s income in savings. This leaves them vulnerable to even small shocks such as an unexpectedly large bill.

Major shocks such as illness or unemployment can be catastrophic and a large proportion of the group is at risk of poverty in old age. Over two-thirds of households in the group have no pension or a frozen pension compared with 41% among the higher income group. In fact, the percentage of people actively contributing to a pension has fallen over time across all groups.

With little ability to save and 100% mortgages no longer available, the aspiration of home ownership is moving out of reach, especially for younger people in the group who are unable to accumulate a typical first time buyer deposit. For the first time, the majority of under 35s in the low to middle income group now live in the private rented sector.

Where low to middle income households do manage to buy their own home, they often remain in a vulnerable position. Around one-quarter of mortgage holders in the group are already paying more than 25% of their income in mortgage payments. This figure is little changed from the late 1990s, despite the historically low level of today’s interest rates. It is driven in part by the extent to which families have stretched themselves to get on the housing ladder in recent years and in part by the fact that mortgage lenders have not passed on the full extent of record low interest rates to these customers. As a result, many exposed households could face severe financial difficulty once interest rates finally rise.

Overall, debt repayment presents a growing burden among low to middle income house-holds. Among all households with some form of debt in the bottom half of the income distribution, 30% can be considered ‘debt-loaded’; that is, their repayments account for more than a quarter of their gross household income. Just 14% of debtors in the top half are in this position.

New polling conducted by Ipsos Mori for the Resolution Foundation in February 2013 reveals how widespread the living standards squeeze has now become. Nearly seven out of ten people (68%) said that they are cutting back on spending , with women far more likely to be cutting back than men (74% vs. 62%).*

* Polling conducted by IPSOS Mori from 1 February to 3 February 2013 with a telephone sample of 1005 people.